Government funds need regulation

By Jason Yeh 葉家興 /

Wed, Jan 23, 2013 - Page 8

Late last year, the government ordered a performance evaluation of the external management of the Postal Savings Fund, the Public Service Pension Fund, the Labor Pension Fund and the Labor Insurance Fund. The evaluations found not only that performance lagged behind government-managed funds, but also that it fell short of the performance of other funds managed by investment companies.

The Labor Pension Fund’s supervisory committee said that to improve profits during the contract period, the investment company and the fund manager entrusted with the fund’s management engaged in “a bit more trading [than normal],” which resulted in “a situation with slightly more obvious losses” when the market was performing badly.

“A bit more trading” is rather fuzzy. It means that they were buying high and selling low. A pension fund that is required to be sustainable should choose long-term investments to beat stock market fluctuations and make its profits from the risk premium.

However, to achieve their target rate of return, fund managers engage in short-term trading with even greater passion than retail investors. Short-term thinking is the biggest problem with government funds that have been entrusted to external management.

A second problem is the pursuit of absolute returns. Investors are willing to pay higher management fees simply because they hope that the fund manager will be adept at picking the right stocks and creating higher returns. Unfortunately, many studies have showed that the performance of more than 90 percent of experts is disappointing and that they are unable to beat the market. Exchange traded funds (ETF) and other passive management funds often perform better than actively managed funds.

Most of the externally managed government funds have a set absolute rate of return. While a requirement for a high return is well-intended, a look at the past performance of such funds reveals that they rarely meet that requirement.

The requirement for absolute returns is meaningless, and it would be better to invest in stock market-tracking ETFs.

A third problem is insufficient transparency. Web sites for each of the government’s funds currently provide only limited information about the 10 biggest stocks held at the end of each quarter. Any other information, such as the managing investment company’s portfolio and detailed return rates, is lacking.

The authorities say that this is intended to avoid too-frequent updates, since that could make the fund manager focus on short-term investments.

This is very poorly reasoned. The reason a fund manager would focus on short-term investments would be to meet the stipulated absolute return. It has nothing to do with publicizing investment details. Furthermore, there is a difference between managing funds on behalf of the government and normal investment funds because there will be no redemption by retail investors in a government fund.

The result of insufficient transparency is that unscrupulous fund managers cooperate with other big investors to manipulate stock prices, as happened when the manager of the Labor Insurance Fund allegedly manipulated the stock price of Ablerex Electronics Co via dummy accounts, causing the share price to surge from NT$185 at its initial public offering in September 2010 to NT$565 in five trading sessions.

A fourth problem is that supervision is always one step behind. In the Ablerex case, for example, media reports about the surging share price in 2010 caused the Financial Supervisory Commission to investigate the case, but it only issued disciplinary measures in June last year.

The commission said the reason for the delay was that the it had to cooperate with the prosecutors’ investigation, but the Taipei District Court only initiated an investigation into a possible breach of trust and other offenses in November last year, following a legislative interpellation session and media reports.

This gives us an idea of how financial supervision, investigators and the judiciary always are one step behind. When it takes investigators two or three years to take action, the alleged perpetrator is given ample time in which to destroy evidence, agree on a story with other involved parties and rid themselves of any assets obtained.

Although ING Securities Investment and Trust Co has stated that it is willing to compensate for the losses sustained by its manager in the Ablerex case, this is limited to the government fund. Retail investors will likely have to wait a long, long time before they see any compensation.

In a 2010 book, John Bogle, one of the founders of the mutual fund industry, wrote what could be a fund manager’s view of the financial crisis: “The bad news is that we lost a ton of money. The good news is that none of it was ours.”

History tells us that we will never be as careful in managing other people’s money as we are managing our own. If the management of government funds continues to be riddled with contradictions, insufficient transparency and ineffective supervision, leading to management irregularities, it would be better to start investing in index funds that track market performance, rather than paying huge management fees to external managers.

Even Berkshire Hathaway chairman and chief executive Warren Buffett believes that fund management fees are too high and often erode investor interests. On eight occasions, he has publicly recommended index funds, and he even entered into a bet with Protege Partners that the S&P 500 stock index will outperform a collection of hedge funds over a 10-year period if all fees are included.

If even Buffett says that stock market index funds are the best investment over the long term, why would the government think that it would be able to find managers for its funds that could beat the market?

Jason Yeh is an associate professor of finance at the Chinese University of Hong Kong.